Does the above scenario sound all too familiar? Ever receive calls to your office wondering why there are budget cuts when you have a HUGE endowment? You are not alone! Endowments are commonly misunderstood. Just because there is a large dollar value assigned to an endowment does not necessarily mean all that money is available to spend at the drop of a hat. Let’s take a closer look at endowments – their purpose and why money can not be utilized today.
An endowment is a donation of money or property to a nonprofit organization for the ongoing support of that organization. Usually the endowment is structured so that the principal (original gift amount) is kept intact while the investment income is available for use. Part of the balance may be released each year, which allows for the donation to have an impact over a longer period than if it were spent all at once. An endowment may come with stipulations regarding its usage.
A common example is a donor gives $50,000 to endow a name scholarship. Instead of spending the $50,000 immediately, the donor and school endow the fund and limit spending on the fund to match investment earnings. As the fund grows in size from interest, dividends and gains, scholarship money can be awarded. The original gift is kept intact, or as close to, so that there is a longer impact on the student population and school. Not only do organizations need to follow donor’s wishes there also may be a binding legal contract. Often an organization is not allowed to use donor money for purposes outside the intended designation.
In addition to donor’s intent, endowments often invest in a diverse portfolio. Depending on the investments, money may not be liquid on a daily or even monthly basis. When I say liquid, I am referring to an investment’s liquidity. Liquidity is how easily an asset or security can be bought or sold in the market and converted to cash. Donor money may be invested in assets that require 90 day or even 6 months’ notice to liquidate into cash. Therefore, although we hold the asset at a certain value, cash may not be readily available to spend today.
We’re In It For the Long Haul
Endowments are a valuable financial asset for nonprofits. Although it may be nice to pull from an endowment in hard times, spending conservatively will have a greater impact over a longer period of time. Hope this helps demystify some of the misconceptions found in the endowment world!